Cannabis Accounting 101: How to Stay Compliant, Reduce Risk, and Maximize Profits

Cannabis operators are challenged at every turn. Regulatory and tax compliance are essential to business continuity, but stringent requirements often come at a cost.

Considering the limitations placed upon the industry by IRC 280E, which prevents cannabis businesses from deducting even the most basic business expenses at the federal level, margins are tight (a gross understatement). To ensure success in this challenging environment, operators must apply diligence with their accounting to stay compliant, minimize risk, and maximize profits.

Today, we’ll discuss cannabis accounting basics, helping operators stay on top of their obligations so they can focus on building a thriving business.

What is Cannabis Accounting?

Accounting is an essential component of running a profitable business. Though this is true in any industry, it is especially critical in the highly regulated cannabis landscape.

Cannabis accounting helps ensure that you accurately track sales, expenses, taxes, and inventory, enabling smooth processes not just for tax filing, but also for accurate forecasting and business planning.

Accounting best practices include:

·       Stringent cash management

·       Tax collection tracking

·       Accurate cost of goods sold (COGS) tracking

·       Timely filing and payment with local, state, and federal tax authorities

·       Compliance with federal and state tax rules and regulatory guidelines

·       Maintaining meticulous records and process documentation

By implementing accounting best practices, operators can avoid penalties and ensure they are always prepared for the inevitable audit.

Avoiding Risk in Cannabis Accounting

Poor cannabis accounting practices can increase risk on many fronts. Poor financial management can lead to inaccurate cash flow projections and cash shortfalls, putting the business at a disadvantage.

Here are a few areas where poor accounting practices might put a business at risk:

·       Overestimating sales. Overestimating sales can lead to false optimism, resulting in overspending and a subsequent cash shortfall. Accurate sales forecasting is crucial for informing business planning and growth, as well as ensuring sufficient cash reserves to cover expenses.

·       Underestimating expenses. While unexpected costs may occasionally arise, most businesses can reasonably predict their operating expenses. Having an accurate expense forecast helps you prepare for what’s ahead and enables you to plan for emergencies.

·       Failing to factor in license fees and other costs, especially at startup. License fees and renewals can be costly, but keeping your license current is crucial for maintaining business continuity. Cannabis accounting should always include a compliance calendar, allowing financial stakeholders to anticipate and plan for upcoming expenses.

·       Not tracking all taxes accurately. Sales tax, excise tax, and local cannabis taxes can be complex to track, but they must be charged, reported, and tracked accurately. Most cannabis-specific point-of-sale systems enable tax tracking. Failure to use a specialized cannabis POS overcomplicates accounting and may result in tax noncompliance.

·       Neglecting to pay taxes and fees on time. Tax filing and payment due dates should be included on your compliance calendar—late filing and payments result in fines and penalties, which can eat into your profits.

·       Inaccurately reporting income or cash transactions may over or underinflate your projections and could trigger an audit. As cannabis is a cash-heavy industry, the IRS applies additional scrutiny, underscoring the need for accurate and compliant cash tracking.

·       Lack of secure cash handling processes. The cash handling process should be consistent, repeatable, secure, and well-documented to prevent fraud and ensure accuracy.

·       Inaccurate inventory valuations and tracking can lead to inaccurate COGS reporting, which reduces profits and increases the likelihood of regulatory scrutiny. Since COGS-related costs are the only expenses cannabis businesses are allowed to deduct, they must be allocated accurately, tracked religiously, and reconciled to the state’s seed-to-sale system.

Any of the above can result in various problems, not the least of which are cash flow issues that undermine daily operations.

Now that we understand the hot-button areas, let’s discuss how good accounting practices can address them.

Cannabis Accounting Best Practices: Avoiding Risk and Enhancing Profitability

First and foremost, cannabis accounting must endeavor to minimize the impact of IRC 280E. This involves accurate tracking and documenting COGS, which can be highly complex. The more attention you pay to this point in particular, the more money you can keep in your business. A little strategy is required to ensure your calculations are precise and comply with state and federal laws.

Complicating COGS calculations even further, some states have decoupled from 280E. While decoupling can provide some relief at the state level, it creates more complex reporting requirements. If this applies to your business, we strongly suggest maintaining separate ledgers for state and federal to simplify tax filing.

COGS expenses consist of anything related to the product you sell: cultivation, testing, processing, packaging, storage, transportation, and security (as it applies to inventory), and related payroll costs are included in COGS.

Achieving more accurate COGS calculations requires a detailed understanding of cost-driving activities. For example, payments made to licensed third-party services engaged in production or manufacturing activities are eligible as COGS.

Tracking COGS expenses ensures accurate reporting and forecasting. Inventory can also be allocated to COGS under 471(c). Since inventory is tracked through state-mandated seed-to-sale, all systems must reconcile. Performing regular audits is essential to ensure alignment between POS, accounting systems, physical inventory, and seed-to-sale systems.

Cash Handling Best Practices

Cash is another significant accounting concern for cannabis businesses, as poor cash handling can result in loss and noncompliance.

In best practice, cannabis operators should establish a consistent cash handling process, ideally involving two individuals monitored by both digital and physical surveillance. Smart safes are recommended as they can track cash transactions at the user level and provide a verifiable audit trail.

Cash reporting is another issue entirely. Large cash transactions must be reported on IRS Form 8300, and all cash transactions must be handled and tracked the same way as any other type of payment. The IRS can anticipate your income based on the volume of product sold, tracked through seed-to-sale. Shortfalls will undoubtedly result in additional scrutiny and possibly audits for previous years. There is no room for error!

The Cannabis CPAs at Growise Have Your Back

While cannabis accounting is a minefield of complexity, working with a qualified cannabis CPA can help. Speak to the experts at Growise today, and let’s get your books in order.